Monday, March 7, 2011

JOBS/SOLD Synovus Junior Bond Maturing 2017/Bank Loan Funds/Harland Clarke Earnings/PRWCX

The Labor Department reported last Friday that nonfarm payroll increased by 192,000 in February and the jobless rate fell to 8.9%.  Employment Situation Summary  The private sector added 222,000 jobs, whereas state and local governments shed 30,000 during the month.  Local governments have eliminated 377,000 jobs since September 2008.  The loss of state and local government jobs is likely to continue for some time.

The average workweek remained unchanged at 34.2 hours and the average hourly earnings increased by one cent to $22.87 per hour.  The seasonally adjusted U-6 number, which includes those working involuntarily part time and persons marginally attached to the workforce, fell to 15.9%. Table A-15. Alternative measures of labor underutilization  The reports for December and January were revised to show 58,000 more jobs.

On the jobless rate decline to 8.9%, it is important to put that number in perspective, reading it in conjunction with the labor participation rate. This last jobs report showed the participation rate at 64.2%, the total number of adults who either have a job or are actively looking for one. Table A-1. Employment status of the civilian population by sex and age That participation rate is the lowest in 25 years.  If the participation rate was at the same level as before the Near Depression, the unemployment rate would be 11.5% in February,  The participation rate in December 2007 was at 66%.

Some of those people who have left the workforce have joined the Social Security Disability Insurance roles, as noted in the WSJ article.  The number of people drawing disability has increased 14% since December 2007 to 10.2 million persons.  I recently noted that one out of twenty adult Americans are now claiming to be disabled, based on a story from CBS News that focused on alleged fraud. I also noted a story in the NYT about the disability farce at the Long Island Railway, where almost 98% of retired workers were awarded disability, with a large chunk funded by social security.  Of course, after an investigation, nothing much happened. NYT  

The longer dated treasuries rose in price and fell in yield last Friday.  The 10 year treasury note closed with a yield of 3.494%.  The DJ-UBS Commodity index closed at 169.28.   Crude Oil rose to 104.91 per barrel. The average price for gasoline rose 28 cents over ten days, ending at  $3.471 per gallon for regular.  Gold closed at 1433.1 per ounce.  Both the Canadian and Australian dollars are now trading at over par against the U.S. dollar, so it takes more than 1 USD to buy either 1 CAD or 1 AUD.

FXC, the currency ETF for the Canadian dollar, closed at $102.32 last Friday, and that ETF was at $77 in early March 2009.  FXC Historical Prices  A rise in this ETF's price indicates CAD strength against the USD.  CAD/USD Currency Conversion Chart

On the paltry increases in wages for those who have jobs, the FED believes that inflation is nothing to worry about.  I would agree, provided you do not have to pay for food and gas, electricity, health insurance, and college tuition.  I have also noticed that other insurance bills have started to rise faster than the rate of inflation.   My auto insurance jumped last year.  I have never had a speeding ticket, or any other violation, and my last accident was in 1981 when a car bumped into my rear on an ice covered road going about two miles per hour.

Notwithstanding the accelerating rise in commodity prices,   Credit Suisse believes that a FED rate hike is no likely before the end of 2012.

This story from PolitiFact shows how Glen Beck stokes his outrage with blatantly false information.  The story focuses on his claim that Michelle Obama had 43 people working on her staff while Nancy Reagan had three, both assertions are false.

I am cutting way back on my trading activity and did not even place an order last Friday.

1. Sold 1 Synovus Junior Bond at 93.05 Last Thursday (Junk Bond Ladder Strategy )(see Disclaimer):  This was one of the lowest yielding junk bonds in my ladder strategy.  The bond matures in 2017 and has a 5.125% coupon.  Pricing has improved since my purchase  at $86.3 last January, possibly due to SNV's announcement that it was considering strategic options according to some press reports. TheStreet Some investors believe that SNV may be sold to a more solvent financial institution and have consequently bid up the price of this deservedly rated junk bond.  While netting some interest and a small profit, I also improve the yield of my portfolio of junk bonds by selling this relatively low yielding one.

I am keeping for now the other SNV junior bond that matures in 2013, bought at 94

2. Harland Clarke (own senior bond (Junk Bond Ladder Strategy):  Harland, a wholly owned indirect subsidiary of M & F Worldwide, reported 4th quarter net income of 26.4 million on a 3.6% decline in revenues to 406.4 million.   Adjusted EBITDA decreased to 117.1 million for the 2010 4th quarter compared to 124.2 million in the 2009 4th quarter.   For 2010, the company had net income of 114.2 million dollars, up 1.9% compared to 2009, both of those years included a number of one time gains and losses. Operating income rose to 296.7 million in 2010.  Bought 1 Harland Clarke 9.5% Senior Bond Maturing 5/15/2015 (see FINRA - Investor Information)

3.  Floating Rate Loan Funds:  There was a cautionary article in the weekend WSJ about these senior floating rate bank loan funds.

Many of these funds own adjustable rate loans that generally pay a spread over a short term rate, such as the 3 month LIBOR rate.  These funds have some appeal when interest rates start to rise.  While the coupon sensitivity to rising rates mitigates interest rate risk, it comes with a price. Most of these loans are junk rated and are frequently associated with leveraged buyouts, where a company is loaded up with a ton of debt in a going private transaction, thereby making it a greater credit risk. So, there is a trade-off for interest rate sensitivity. One downside is an enhanced credit risk for many of these loans.  Frequently, the senior bank loans are secured however, which lessens the credit risk.  I am only familiar with those that are secured senior loans, some may not be which is why I just said "frequently".  

Another problem is obvious.  All short term rates are still abnormally low and likely to remain that way for many more months.  Consequently, investors are not being paid much now to assume the credit risk of a default.   I have recently been buying junk rated bonds, with fixed coupons, that pay me over 10% in many cases. A bank loan paying a 3% spread to 3 month LIBOR has in effect a 3.31% coupon.  In other words, the yield spread between a fixed coupon senior bond and a senior secured floating rate loan is a high price to pay for the inflation protection of the floating rate security.

The 3 month LIBOR rate closed last Friday at .31%. ( see Markets Data at the under consumer money rates, right hand column). So, while floating rate loans have some interest risk protection, those that pay a spread over a short term rate are not providing much in the way of compensation for their credit risk. 

Another issue is that these loans are frequently illiquid, which raises two problems.  Are their values being priced right by the fund, and how much would they have to marked down to sell in an unfriendly market environment? 

The article in the WSJ points out that these loans have risen in value, as investors have poured 10.6 billion into these funds during 2011 so far. Many new floating rate funds have been launched to soak up those investor dollars.  One of the older ones, Fidelity Floating Rate (FFRHX), has an uninspiring ten year record in my opinion, though it did perform well in 2010 as the entire junk bond market had a robust recovery from its ghastly performance in 2008.  FFRHX - Fund returns  I made this point in an earlier post from this year:  Item # 2 Bought 100 of the Bond CEF GFY @ 16.42   I am just underwhelmed by the performance of these funds. I did recently add 100 shares of a CEF, GFY, that has floating rate loans, but the last report for that fund shows heavy involvement in mortgage securities rather than bank loans used to finance leveraged buyouts.  

Instead of buying a mutual fund, I have been buying exchange traded floating rate securities that pay the greater of a guarantee or some percentage over a short term rate. The opportunities were just tremendous when I started to buy those securities in the summer of 2008, with many purchases made at over a 50% discount to par values. Those opportunities are long gone. For long time readers, this is really old news.

Those securities fall into two general categories: Equity Preferred Floating Rate stocks and Synthetic Floaters. Even today, I would prefer buying some of those securities rather than a bond fund that invests in floating rate senior loans for several reasons. First, I do not incur the ongoing costs associated with owning a fund.  Second, I can achieve a broad diversity with those securities. Third,  the equity preferred floaters pay qualified dividends that still have a tax advantage compared to the highest marginal rate paid for interest distributions. And lastly, by concentrating my buying in those that at least have a guarantee when short rates are low, and buying those at a discount to par value, I receive a yield in excess of what the funds pay.  I would add that I have also booked a large number of profits trading those securities, and still have a number bought at truly absurd prices in retrospect.  Floaters: Links in One Post

The article in the WSJ also points out that a new ETF was launched last week by Powershares, the first ETF for bank loans.   Senior Loan Portfolio | BKLN  I noticed that fact last week, and looked at the fund.   I decided to pass on it for now.  The management fee is high at .75%.  In addition, this fund invests some money in other funds, and that adds .18% to the expense ratio, bringing the total to .93. The fund expects that to be .83% over the course of the year.  Still, that is almost 1% clipped off the top per year. The YTM shown for the funds holding is 4.97%. I would also like to emphasize the ratings of the fund's current holdings, which can be found at the sponsor's web site. 

I am familiar with many of firms whose bonds are owned by this fund:   Holdings  In some cases, I own a fixed coupon issue from the same company (e.g. Harland Clarke, Hawker Beechcraft, with the later one making the OG nervous with just 1 bond). In a majority of cases, these companies were taken private, and loaded up with a mountain of debt by their new owners, making them far riskier credits than they were before being taken private.   

The fixed rate coupon bond that I own from Harland is classified as a senior unsecured bond.  My current yield for that loan which matures in 2015 is around 9.5%.   The ETF BKLN has a listing for a Harland security maturing on 6/30/2014 with a "2.79%" coupon.   That loan is referenced at page 45 of Harland's recently filed  Form 10 K.  It is a senior secured loan that pays a spread over one of two formulas containing short rates.   The  aggregate principal amount of that term bank loan is 1.8 billion.   While the owners of that bank loan have more security than my 2015 unsecured senior note, I am being paid considerably more and both securities are rated junk.  Item # 1 Bought 1 Harland Clarke Senior Bond Maturing 2015

Still, I may at some point add a small position at BKLN since I frequently buy securities that provide me with more diversification, and a fund with senior floating rate bank loans does add to diversity.

4. Balanced Fund with An Allocation to Bank Loans: For many investors, an alternative would be a balanced mutual fund, with a much better long term track record, that incorporates these bank loans into its bond allocation.  Over the weekend, I received the annual report for the T. Rowe Price Capital Appreciation fund  (PRWCX) which is not available as a no transaction fee fund from most brokerage companies.  It is currently available on a NTF basis at TD Ameritrade. Therefore, it is best from a fee perspective simply to have an account at T. Rowe that has several mutual funds that I like.

As of 13/31/2010, this fund had a 6.3% weighting in bank loans, valued at 675.779 million dollars.  Another 2.8% is invested in an institutional fund that invests in floating rate securities which requires a 1 million dollar investment and is rated 5 stars by Morningstar.  T. Rowe Price Instl Floating Rate Convertible stocks and bonds accounted for 7.3% and fixed coupon corporate bonds were weighted at 4.9%.  Cash was high at 13.6%.  Common stocks, mostly large American companies, was at 66.6%.  A chart at page 11 shows that $10,000 invested in the S & P 500 in 12/2000 would be worth $11,507 and that is after an extremely robust rally since March 2009 of close to 100%.  This fund was at $22,685. ( SEC Filed Annual Report:  T. Rowe Price Capital Appreciation Fund - December 31, 2010)

This is a link to the sponsor's web page: T. Rowe Price Capital Appreciation Fund (PRWCX)

This is a link to the  Morningstar page. 

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